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Employee share ownership is an effective tool for companies to recruit, retain and motivate employees. Not only start-ups, but also small and medium-sized companies are increasingly benefiting from the advantages of employee participation schemes.
A legally secure contract that is individually tailored to the company is an indispensable foundation for a successful employee participation program. The legal and corporate strategy complexity associated with the introduction of employee participation programs entails a multitude of technical terms, abbreviations and special principles, each with great significance for the big picture.
This glossary provides an overview of the basic concepts and key terms relating to employee participation. The aim is to provide an initial understanding of the mechanisms and aspects surrounding employee share ownership programs and their role in the modern corporate world. From basic definitions to specific contractual clauses, the key aspects are explained to provide an introductory insight into the topic of employee share ownership.
For a more detailed and comprehensive examination of the topic of employee participation programs, we recommend personal, legal and entrepreneurial individual advice and examination of your situation to ensure that the central contractual contents meet your expectations.
Employee share ownership schemes are part of the company incentive systems used by companies to attract employees and retain them for as long as possible, but also to motivate their employees in the long term.
To this end, employees contractually participate in the company's assets (capital) or profits by receiving shares or options on shares or entitlements to certain payments. In addition to profit participation rights or silent partnerships, the various types and forms of employee share ownership also include ESOPs (Employee Stock Option Plan) and VSOPs (Virtual Stock Option Plan).
ESOP is an abbreviation for "Employee Stock Option Plan". With an employee share ownership plan in the form of an ESOP, employees are given the option to acquire part of the share capital at predetermined conditions. Employees are then entitled to profit distributions on the annual profit and exit proceeds in the event of a sale, depending on their shareholding. They also enjoy voting rights as shareholders.
The bureaucratic hurdles for the transfer of real shares are comparatively high, as notarization and entry in the commercial register are required.
"VSOP stands for "Virtual Stock Option Plan" and works in a similar way to an ESOP. The focus is also on employee participation in the company's success. However, this is only "virtual", i.e. no real company shares are transferred. The basis of a VSOP is a contractual agreement that stipulates that employees are treated as shareholders in terms of property rights, but without being such.
Virtual shares, or virtual employee share ownership plans, offer the advantage over ESOPs that the usual administrative and corporate law effort involved in transferring "real" shares is eliminated.
The so-called "cliff" is one of the most common and useful clauses in a contractual agreement on employee participation. The cliff period regulates the length of time that employees must remain with the company before they can receive any shares at all. Accordingly, no shares are transferred in the event of termination within this period. The right to acquire shares only begins at the end of the contractually agreed cliff period or when the specified date is reached.
Vesting is a standard clause in contractual agreements on employee participation programs. The vesting period specifies the staggered period in which employees gradually become entitled to their promised shares or participations, e.g. after a certain length of service or the achievement of previously defined targets. During this phase, the employee receives shares according to a fixed schedule, often in annual or monthly installments. Only at the end of the vesting period do the employees have full rights to all promised shares and these become vested. This mechanism is often used to promote the long-term loyalty of employees to the company. It also prevents employees from leaving the company shortly after participating and still benefiting from the participation received.
The vesting period is usually preceded by a minimum period ("cliff") during which the beneficiaries must at least work for the company in order to obtain any entitlements at all.
In the event of an exit/sale before the end of the vesting period, it is customary to agree that all virtual shares to which the beneficiary is entitled under the VSOP are deemed to have vested ("accelerated vesting").
Nevertheless, in practice it is often agreed in the case of accelerated vesting that the beneficiary undertakes to continue working for the company for a certain period after an exit before the end of the vesting period ("post-exit period") or otherwise loses some of his phantom stocks.
A "fade-out provision" describes provisions in employee participation programs in which the rights to employee shares are gradually reduced if certain conditions are no longer met, for example if an employee leaves the company prematurely. Instead of the immediate loss of all employee rights, the shares are reduced over a fixed period of time.
A fade-out clause can therefore be used to agree that (virtual) shares that have vested for a beneficiary who leaves the company as a good leaver before a possible exit are "phased out" to a residual amount of, for example, 80% of the virtual shares that have actually "vested" if the exit does not take place until (well) after the employee has left the company.
This provision offers a smooth transition and can help to minimize conflicts and ensure fair conditions for both sides - employee and company.
However, such a fade-out clause, which is quite common in the USA in particular, may be invalid under German law in terms of unreasonable disadvantage in the sense of content control under general terms and conditions law. ("Protection of acquired rights").
A "buy-out clause" offers the beneficiaries the right to sell their already "vested" shares, i.e. shares that have become non-forfeitable and to which they are entitled after the vesting period has expired in full, to the company.
Such a clause is most likely to be considered for companies whose liquidity situation permits this and where an exit within a reasonable period of time is unlikely.
In order to regulate different scenarios in the event of employee departures, employee participation agreements often contain so-called "leaver clauses". These clauses define the rights and obligations of the employees involved and the company in the event of an employee leaving. Leaver clauses regulate, for example, the specific reasons why shares are to be transferred back in full, in part or not at all. To this end, leaver clauses should be formulated clearly and comprehensibly in order to prevent legal disputes. Leaver clauses can be divided into different scenarios, so-called "good leavers", "bad leavers" and "grey leavers".
A good leaver is an employee who leaves the company without having breached contractual agreements or statutory provisions. The reasons for this can be ordinary termination, retirement or personal reasons. In such situations, the good leaver normally retains their acquired shareholding and can benefit from possible profit distributions or sales proceeds.
Bad leavers are beneficiary employees who leave the company under unfavorable circumstances, for example due to conduct in breach of contract, termination without notice or a serious breach of duty. In such cases, the employee participation is returned or forfeited in order to protect the interests of the company and the remaining employees.
In practice, the intermediate stage for leaver clauses, the so-called "grey leaver", has become established in constellations involving the beneficiary's own termination. This is intended to cover cases of self-termination that are more advantageous compared to a bad leaver and more disadvantageous compared to a good leaver. Possible agreements of a grey leaver clause would be, for example, that only 70% of the virtual shares vest, i.e. become non-forfeitable, in the event of termination before the end of the vesting period, provided there is no classification as a bad leaver.
Within the framework of bad leaver clauses, shares that are transferred free of charge or against payment of the mere nominal value as part of employee participation can be taken away again free of charge or only against payment of the mere nominal value in accordance with the so-called "naked-in/naked-out principle". According to this principle, beneficiaries leave a company as they came in: "naked", i.e. without shares.
In addition to the name of the beneficiary, the subscription certificate also shows the specific number of shares allocated in each case. The subscription certificate must also contain provisions that deviate from the ESOP/VSOP framework (e.g. different base value of the (virtual) shares or different vesting rules for employees who have been with the company for a longer period of time).
The subscription certificate also contains the consent of the beneficiary employees to the provisions of the ESOP/VSOP and, from a legal perspective, constitutes the binding conclusion of the contract between the employees and the company.
A "share deal" describes the special case of a change of shareholder in the course of an exit. With regard to ESOPs/VSOPs, it is important to determine the number of shares acquired that constitutes an exit case within the meaning of the agreement, so that, for example, the realization of the virtual shares is triggered. An exit case as a "share deal" would exist, for example, if a new shareholder or a group of new shareholders acquires more than 50% of all shares in the company in a single transaction or in close temporal connection. Other exit cases include asset deals or an initial public offering (IPO) of the company.
An "asset deal" describes the special case of a change of shareholder in the course of an exit. With regard to ESOPs/VSOPs, it is important to determine the number of shares acquired that constitutes an exit case within the meaning of the agreement, so that, for example, the realization of the virtual shares is triggered. An exit case as an "asset deal" would exist, for example, if the company sells or transfers all or almost all of its assets (more than 50% of all assets of the company by market value) to a third party. Other exit cases include "share deals" or an initial public offering (IPO) of the company.
It is possible to extend the (virtual) participation beyond the exit case to include participation in dividends or profit distributions resolved by the company. In this case, the relevant dividend is the dividend attributable to the respective number of actual shares in the company.
At the employer, profit distributions to real shareholders must be made from the annual profit. However, payments made on the basis of a VSOP are simply operating expenses and therefore reduce the profit. As an outflow of assets only takes place when the annual profit is determined, employee share ownership plans are generally ideal - and better than a high salary, for example - for ensuring liquidity.
The strike price, also known as the exercise price, is the value per share at the time of issue to the employee.
In the event of an exit, the beneficiaries only participate if the value of an actual share (which a buyer is prepared to pay) exceeds the strike price. The beneficiaries therefore only participate in the difference between the selling price of a share and the strike/option price at the time of grant.
It is standard market practice to deduct so-called liquidation preferences from the exit proceeds actually received by investors. Liquidation preferences are nothing more than a preference for investors in the distribution of exit proceeds. This means that the investors receive (at least) their investment back first before the remaining exit proceeds are distributed to the other shareholders.
The beneficiary employees must pay tax on the shares received in an ESOP as a non-cash benefit in accordance with Section 8 (2) EStG. At the same time, they lack the necessary liquidity, as they can only achieve this by selling the shares. Although the legislator has partially remedied this situation with Section 19a EStG, the standard only applies for a limited period of time and up to clearly defined company sizes.
Disclaimer: The contents of the information offered at vsop-direkt.de do not constitute legal advice. If you need a legal examination of your individual case, please contact our specialized team: beratung@esop-direkt.de
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